Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues:
Tax treatment of proceeds for sale of client lists, goodwill, and non-competition agreement
Position:
Sale of client lists and goodwill is ECE; payment for non-competition agreement to corporation is goodwill and therefore an ECE; payment for non-competition agreement to shareholder is a sale of property and therefore is a capital gain.
Reasons:
Purchase of client lists with non-competition undertaking is the purchase of ECE. Sale has same treatment since the "mirror image test" applies and vendor is carrying on a business. Sale of goodwill as part of a sale of a business is ECE -See IT-386R and IT-143R2. Non-competition payment received as part of the sale of the business by the vendor of the business is goodwill and therefore ECE - See IT-330R. However, if received by shareholder and there is no sale of the shares by the shareholder, the payment constitutes proceeds of disposition for a right to compete, which is "property" under the Act. Treatment is therefore capital gains. Fortino et al does not apply to these circumstances, and is under appeal in any event.
980014
XXXXXXXXXX N. Mondou, M.Fisc.
April 27, 1998
Dear XXXXXXXXXX:
Re: Sale of customer lists and contracts and non-competition agreement
We are replying to your letter of November 17, 1997, in which you requested our opinion of how payments for customer lists and goodwill, and for a non-competition agreement should be reported for income tax purposes.
You indicate that a corporation is contemplating entering into an agreement to dispose of one of the divisions of its business. Under this agreement, the purchaser will acquire all of the customer lists and customer contracts pertaining to this division of the business. The purchaser will also acquire certain inventory and equipment pertaining to this division of the business. The vendor corporation will continue to operate another division of its business, with that other division selling to many of the same customers which are customers of the division to be sold.
As part of the agreement, the vendor corporation and its sole shareholder will execute a non-competition agreement. Under the terms of the non-competition agreement, the vendor corporation and its shareholder will refrain from engaging in a similar business for an agreed-upon number of years and within an agreed-upon geographical territory. The vendor corporation and its shareholder will not be precluded by the non-competition agreement from carrying on with the remaining business of the vendor corporation's other division.
The non-competition agreement will be a separate contract from the agreement governing the sale of the customer lists and contracts. However, the agreement governing the sale of the customer lists and contracts will specify the allocation of the price approximately as follows:
customer lists and goodwill $ 900,000
customer contracts 0
non-competition agreement 100,000
inventory cost
equipment 10,000
Although the vendor corporation's sole shareholder will be a party to the non-competition agreement, he will not be entitled to receive any amount directly from the purchaser. All of the $100,000 payable in respect of the non-competition agreement will be payable to the vendor corporation.
You also requested our opinion as to the tax treatment of the payment received by the shareholder, should he receive instead of the corporation the payment of $100,000 for the non-competition agreement. You referred to the decision in Fortino et al. v. The Queen, 97 DTC 55 (TCC).
Written confirmation of the tax implications inherent in particular transactions are given by this directorate only where the transactions are proposed and are the subject matter of an advance ruling request. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. Therefore, while we are unable to provide an opinion in respect of the situation outlined in your letter, we are prepared to offer the following comments.
For the purpose of this letter, we assumed that the operations carried on by the various divisions of the vendor corporation are separate businesses as discussed in Interpretation Bulletin IT-206R.
According to subsection 14(1) of the Income Tax Act ( the “Act”), an eligible capital amount is an amount determined under subsection 14(5) of the Act, which is an amount resulting from a disposition of property where, if any payment had been made after 1971 by the taxpayer for that property, such payment would have qualified as an "eligible capital expenditure" for the business. Therefore, the proceeds received from the sale of a client list will be eligible capital property if, had the vendor made a payment to acquire the client list, such payment would have been an eligible capital expenditure to the individual.
In that respect, where a purchaser carrying on a business acquires a list of clients from a company that agrees not to compete with the purchaser in the particular business to which the list of clients relates, the payment to acquire the list is generally considered to be an expense on account of capital that is an eligible capital amount. Therefore, a payment received in the same circumstances by the vendor corporation would be an eligible capital amount which is subject to the provisions of section 14 of the Act.
Where a person carries on a business for a period of time and then sells the business together with its associated goodwill, the sale of the goodwill is a disposition of eligible capital property. The proceeds would therefore be eligible capital amounts subject to the provisions of section 14 of the Act.
Where capital properties of a business are sold, a non-competition convenant, given by the vendor not to carry on a competitive business, is considered to be in respect of the disposition of the goodwill of the business and is therefore a disposition of eligible capital property. Therefore, section 14 of the Act will apply.
An amount received for a non-competition covenant by a shareholder in circumstances where he or she does not dispose of the shares of the company carrying on the business, would not qualify as eligible capital property as the shareholder is not carrying on any business in a personal capacity. To qualify as eligible capital property, there must be a business or former business carried on by the taxpayer to which the amount received relates.
In our view, the payment so received by the shareholder would be consideration for his or her right to compete. This right is "property” as defined in paragraph 248(1) of the Act. Therefore, this transaction would be a "disposition" as defined by section 54 of the Act, i.e. a transaction or event entitling a taxpayer to proceeds of disposition of property. Consequently, the total amount received by the shareholder of the vendor corporation would be considered a capital gain.
Fortino et al. v. The Queen involved a situation where shareholders received payments for non-competition agreements as part of a sale of the shares of a company, which is not the situation you described. Moreover, this case is currently under appeal
Finally, we wish to stress to you that under section 68 of the Act the parties must make a reasonable allocation of the consideration among the assets sold. If the allocation is unreasonable, the Department can apply the provisions of section 68 to deem what may reasonably be regarded as the proceeds for the various assets, including the goodwill.
We trust that these comments are of assistance.
Yours truly,
P. Spice
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
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